IRA strategies to lower your tax bills

SAN FRANCISCO (MarketWatch) — Higher tax rates are coming in the years ahead — that seems all but certain. Given that prospect, how should you manage your retirement accounts?

IRAs and taxes: Is it time for a Roth?

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What's your tax rate going to be when you retire, and is a Roth IRA for you? In this edition of MarketWatch's Retirement Adviser, Andrea Coombes talks with Ed Slott, host of IRAHelp.com, and Jack Nuckolls, head of private client tax services at BDO.

At a recent MarketWatch Retirement Adviser event in San Francisco, two experts spoke about strategies to mitigate the negative effect of taxes on retirement savings.

One of the Retirement Adviser panelists said that the likelihood of higher tax rates in the future means Roth IRAs — to which you contribute after-tax money and all distributions, including investment earnings, later come out tax-free — are a good choice for many savers these days.

“If there’s uncertainty, Roth IRAs remove the uncertainty of what future tax rates might be,” said Ed Slott, a certified public accountant, founder of IRAHelp.com and author of “The Retirement Savings Time Bomb...and How to Defuse It.”

Unless Congress acts, the Bush-era income-tax rates are slated to expire at the end of 2012, meaning tax rates will rise, with the top income-tax rate jumping to 39.6% from 35% currently.

Also in 2013, a piece of the health-care reform law goes into effect: For high-income taxpayers, that provision means “an additional 3.8% Medicare tax on investment income that most people are not that aware of yet,” Slott said. That brings the highest marginal tax rate, for some taxpayers, to about 43.4% before state and local taxes, he said.

TAXES

Big tax bills can devastate your retirement
savings. MarketWatch's Robert Powell and Andrea Coombes talk about strategies to employ before and during retirement to lower your taxes.

“That may be the breaking point,” Slott said. “I think the planning has to be done right now, in 2012. At least we know what the tax rates are,” he said. “Now, for many people, is the time to strike,” Slott said.

Retirement savers with large lump sums in traditional IRAs face the prospect of required minimum distributions when they turn 70 ½ — at whatever tax rate applies at the time. “If they don’t convert, at 70 ½ they’re going to be forced to take that money out in pieces for the rest of their lives at whatever the prevailing rate is at that time,” Slott said.

Partial conversions

Still, an IRA-to-Roth-IRA conversion — which triggers income tax on the amount converted — may not make sense for someone who sees a big tax hit from other income sources in the same year.

“Every situation is different,” said Jack Nuckolls, national director of private client tax services at accounting firm BDO, and also a panelist at the MarketWatch Retirement Adviser event.

“For example, here in the Bay Area, a lot of clients are contemplating maybe exercising stock options this year, which generates a lot of ordinary income, or maybe if it’s an incentive stock option, it’s alternative minimum tax,” Nuckolls said.

“Those types of nuances within an individual return can have a huge impact on the decision to convert from a regular IRA to a Roth, and the size of that conversion in any given year,” Nuckolls said.

One strategy — with an eye on the distributions you’ll be forced to start taking from an IRA once you turn 70 ½ — is to start converting pieces of your traditional IRA to a Roth before you reach that age.

By converting just a portion of the account each year, you might be able to avoid having the distributions from each conversion push you into a higher tax rate in any given year.

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